Managing Human Capital Risks as Baby Boomers Age

The ERM Initiative was pleased to host Steven Goss, Chief Actuary of the United States Social Security Administration, as the featured ERM Roundtable speaker on December 7, 2007.  Mr. Goss spoke about the complexities of managing risks associated with ensuring adequate funding for the anticipated liabilities of the U.S. Social Security Administration as baby boomers age.

Unique Issues for Managing Risk at the Social Security Administration

Like private enterprises, government sector enterprises, including the Social Security Administration, face a world of uncertainty due to the volatility of potential outcomes that might be on the horizon.  However, planning for risks facing government agencies often require different approaches than those used in the private sector.  Government agencies have no net profits in the long run that might cushion some of the impacts of volatility they face.  Instead, government agencies face an equal dislike for running surpluses due to taxing more than necessary and running deficits due to overspending.  As a result, government agencies, including the Social Security Administration, operate on a pay-as-you-go method whereby there is an equal chance of ending in a surplus or deficit position.

Under this pay-as-you-go method of operation, a constant evaluation at the Social Security Administration involves assessing the risk that Social Security costs will rise over current tax rates.  This dilemma is particularly challenging as life expectancies continue to lengthen for a population with more and more baby boomers entering Social Security eligibility.  Forecasts based on low cost estimates and high cost estimates are continually measured and evaluated to determine if current funding intakes through Social Security taxes will hit the targeted expected funding outflows that will occur as more and more Americans approach retirement.  Managing this risk requires constant evaluation of changes in key drivers to the pay-as-you-go method.

Pay-As-You-Go Depends on Demographics

One of the complexities facing the Social Security Administration is the challenge of being dependent on funding that is directly impacted by the demographics of the U.S. working population who pays Social Security taxes.  Forecasts suggest that the number of workers for each Social Security beneficiary will drop from a current rate of 3.3 workers per beneficiary to 2.0 by the year 2030.  Having fewer workers paying into the Social Security system on the pay-as-you-go method means there will be fewer workers providing funding to pay the benefits to eligible retirees.

Drivers of the Drop in Workers per Beneficiaries

There is much speculation about potential drivers for the anticipated reduction in the worker-per-beneficiary ratio.  Some have argued that workers are working less and retiring earlier.  Others have argued that the reduction is due to longer life expectancy for the U.S. population.  And, some have argued that the increase in undocumented workers who may not be contributing to the Social Security System also leads to a reduction in the number of workers per beneficiary.

While some of the reduction may be attributed to these factors, Goss noted that none of the above factors are the primary driver explaining the anticipated reduction in the number of workers contributing to the Social Security System.  Instead, the primary reason for why fewer workers are available to fund each beneficiary is due to declining fertility rates in the U.S.  By 1990, the “total fertility rate” (TFR) fell to 2.0 from 3.3 TFRs experienced during the 1946-1965 timeframe.  As fertility rates drop, fewer younger workers will eventually begin paying Social Security taxes that will fund benefits for the aging population.

Offsetting Effects

Fortunately, the rise in immigration is helping offset the decline in fertility rates.  The net increase due to immigration is helping replace the younger workforce declines due to lower birth rates.  So, the Social Security Administration anticipates that the U.S. population will grow thus contributing additional younger workers to help fund benefits of the baby boomers as they reach retirement.

In addition to immigration gains, stabilization in birth rates is helping reduce uncertainties about the ability to fund benefits due to retirees.  For the past 15 or so years, the fertility rates have continued to remain at the 2.0-2.1 level.  However, the Social Security Administration is concerned about whether further declines might occur in the future thereby creating additional pressures to maintain benefit levels on the pay-as-you-go system.

Managing Uncertainties

As the Social Security Administration manages the balance of collecting enough to fund future benefit demands, management constantly monitors changes in key demographic drivers, such as immigration, birth rates, retirement ages, and life expectancy.  Risk management techniques at the Social Security Administration include constant monitoring of leading indicators of demographic shifts and regular forecasting of expected ranges of high and low differences in taxes received and costs incurred at specified confidence levels.

Current immigration policies should keep immigration at a stable level and extensions of life expectancy over the next decade are anticipated to equal the extensions of life expectancies realized over the last century.  So, huge changes are not expected due to immigration or retirees living significantly longer.  Additionally, changes in the economy and productivity aren’t expected to have a huge impact on funding sources and obligations due to beneficiaries.

There are risks, however, that these drivers will change and that the Social Security Administration will face the difficult decision of whether benefits will have to be lowered or taxes raised to ensure benefits due to retirees can be funded.  Those decisions will be ultimately dictated by society, which elects policymakers who will debate the extent to which Social Security benefits and taxes should be predictable for retirees and taxpayers, respectively.